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Fillip v. Centerstone Linen Services, LLC

Court of Chancery of Delaware

May 1, 2014

Karl Fillip
v.
Centerstone Linen Services, LLC

Submitted: April 14, 2014

Stephen E. Jenkins, Esquire Marie M. Degnan, Esquire Ashby & Geddes

William M. Lafferty, Esquire John P. DiTomo, Esquire Brendan W. Sullivan, Esquire Morris Nichols Arsht & Tunnell LLP

Dear Counsel:

Anecdotally, it often seems that a company challenging a former official's right to advancement faces the same odds as a gambler placing a large bet on a long-shot at the racetrack. Although rational heads frequently prevail in business litigation, advancement cases rarely boast that feature, and this case is no different. This advancement proceeding has been pending for more than nine months and the company has pressed its arguments at length before two different judicial officers, but has yet to achieve anything more than a pyrrhic victory that likely was erased by the fees it has paid its own attorneys and the fees it has been ordered to pay on behalf of the plaintiff. That trend continues in this latest iteration of the parties' dispute. Unfortunately, Centerstone has been victorious in delaying the inevitable and this case has tested the outer limits of any reasonable definition of a "summary proceeding."

BACKGROUND

The underlying facts are both undisputed and recited at length in the final report I issued on December 3, 2013, and in Vice Chancellor Glasscock's opinion dated February 27, 2014. To briefly summarize, the plaintiff, Karl Fillip ("Fillip"), was the co-founder of Alliance Laundry and Textile Services, a company he sold to the defendant, Centerstone Linen Services, LLC ("Centerstone") in 2008. In connection with the sale, Fillip received a preferred membership interest in Centerstone, which he holds through a wholly-owned Georgia LLC, KF Equity Holdings, LLC ("KF Equity"). When it acquired its equity stake in Centerstone, KF Equity executed a $1 million promissory note in favor of Centerstone (the "Promissory Note").

After the sale, Fillip became a Manager of Centerstone and served as Centerstone's CEO under a Member Service Agreement (the "Employment Agreement"). Fillip resigned as CEO in October 2012 for what he contends was "Good Reason" under the terms of the Employment Agreement.[1] If Fillip resigned for Good Reason, he is entitled to certain severance payments.

When Centerstone disagreed that Fillip resigned for Good Reason and refused his demands for severance, Fillip filed an action in Georgia state court (the "Georgia Action"). Shortly thereafter, Fillip and Centerstone engaged in settlement negotiations and executed a term sheet (the "Term Sheet"), but Centerstone later refused to proceed with the settlement on the basis that the company had "discovered facts suggesting that Fillip had engaged in practices designed to manipulate Centerstone's revenue." In response to Fillip's motion to enforce the settlement, Centerstone argued to the Georgia court that Fillip "fraudulently induced" Centerstone to enter into the Term Sheet and breached his fiduciary duties by failing to disclose during settlement negotiations that he had manipulated revenue to inflate his bonus. The Georgia court ultimately denied the motion to enforce the settlement, finding that there were factual questions as to whether the parties reached a meeting of the minds and as to whether Fillip fraudulently induced Centerstone to enter into the Term Sheet.[2]

Centerstone then filed an answer and several counterclaims against Fillip in the Georgia Action. When Fillip demanded advancement under Article 3.7 of Centerstone's LLC Agreement (the "LLC Agreement") for his attorneys' fees relating to the defenses and counterclaims, Centerstone filed its first amended counterclaims and affirmative defenses (the "Amended Counterclaims"), wherein Centerstone withdrew certain fiduciary duty claims (the "Dismissed Counterclaims") and asserted three counts against Fillip. In the Amended Counterclaims, which were styled as contractual claims, Centerstone alleged: (a) Fillip breached the Employment Agreement "by causing his annual bonus for the period 2008 through 2012 to be significantly overstated" (Count I); (b) Fillip breached the Promissory Note by modifying its terms without authorization (Count II); and (c) the company was entitled to a declaratory judgment regarding the interpretation of Article 14.13 of the LLC Agreement (Count III). Centerstone also asserted a number of affirmative defenses to Fillip's claims, including that Fillip was barred from recovery under the doctrine of unclean hands and based on his own breaches of the Employment Agreement and the LLC Agreement. Centerstone refused to advance Fillip's attorneys' fees and expenses for either the Amended Counterclaims or the affirmative defenses. Fillip then filed this advancement action.

The initial stages of this case required me to resolve two issues: (1) the scope of Fillip's advancement rights under Article 3.7 of the LLC Agreement; and (2) the extent to which Fillip was entitled to advancement in the Georgia Action. After I issued a final report interpreting Article 3.7 and recommending that the Court find that Fillip was entitled to advancement for Counts I and II of the Amended Counterclaims, two of the affirmative defenses, and the Dismissed Counterclaims (the "December 2013 Report"), Centerstone filed timely exceptions under Court of Chancery Rule 144. Those exceptions were referred to Vice Chancellor Glasscock, who issued an opinion on February 27, 2014, finding, consistent with my final report, that Article 3.7 of Centerstone's LLC Agreement "mandates advancement of expenses, including costs, incurred by any Centerstone Manager or Officer by reason of his position as officer or manager."[3] Because the pleadings in the Georgia Action had been amended in the interim, and those amendments may have affected my recommendation regarding the portions of the Georgia Action that were subject to advancement, the Vice Chancellor referred the matter back to me for further proceedings. I then directed the parties to meet and confer, held an office conference with counsel, and asked the parties to submit short letters summarizing the remaining issues requiring resolution and attaching the operative pleadings in the Georgia Action.

Centerstone filed its Second Amended Counterclaims in the Georgia Action on November 25, 2013.[4] In addition to adding KF Equity as a third-party defendant, and adding allegations relating to that third party claim, the Second Amended Counterclaims stripped away much of the detailed factual allegations supporting Centerstone's claim that Fillip overstated his bonus, such as the allegations that he "put his digital foot on the scale" and artificially inflated revenue to manipulate Centerstone's EBITDA, on which Fillip's bonus was based. The Company also removed some of the background supporting its allegation that Fillip breached the Promissory Note by purporting to modify its terms. Nevertheless, the bases for Counts I and II of the Second Amended Counterclaims did not change; Centerstone continued to allege that Fillip breached the Employment Agreement by "reporting" significantly overstated bonuses, and breached the Promissory Note by "purporting to offset the Note with bonus payments to which Fillip was not entitled."[5]

The day before the parties' letter submissions were due in this action, Centerstone filed its Third Amended Counterclaims and Third-Party Claim and Amended Affirmative Defenses ("the Third Amended Counterclaims"). The Third Amended Counterclaims did not change any of the counts or allegations against Fillip beyond those changes made in the Second Amended Counterclaims. Rather, the Third Amended Counterclaims added several new affirmative defenses against Fillip (the "Affirmative Defenses"). In addition to the second and fourth defenses, which I previously concluded were subject to advancement, Fillip now contends that he also is entitled to advancement for the newly pled fifth, eighth, and ninth affirmative defenses. In all, Fillip argues he is entitled to advancement for Centerstone's defenses alleging (1) Fillip breached the Employment Agreement and the LLC Agreement (the "Second Affirmative Defense"), (2) Fillip's claims are barred by the doctrine of unclean hands (the "Fourth Affirmative Defense"), (3) Fillip breached his "duty of good faith and fair dealing and/or his obligation to act with fidelity toward Centerstone" (the "Fifth Affirmative Defense"), (4) Fillip's claim to enforce the Term Sheet is barred by the doctrine of fraudulent inducement (the "Eighth Affirmative Defense"), and (5) Fillip's claim to enforce the Term Sheet is barred by the doctrine of mistake (the "Ninth Affirmative Defense").

During the post-remand office conference, the parties discussed what should constitute the record for purposes of resolving Fillip's entitlement to advancement in the Georgia Action, and specifically whether the parties' summary judgment briefs submitted to the Georgia court should be considered by this Court. I declined to consider the summary judgment briefs and other submissions to the Georgia court, concluding that expanding the record beyond the operative pleadings would unduly complicate these summary proceedings and threaten to devolve into a second plenary proceeding regarding the merits of the underlying litigation. After the office conference, however, the Georgia court issued an order granting in part and denying in part the parties' cross-motions for summary judgment (the "Georgia Order"). Both parties alerted me to the Georgia Order, and I have considered that order for purposes of my analysis. Although generally I believe that advancement actions should be resolved based on the contract at issue and the operative pleading in the underlying litigation, this Court cannot ignore a decision issued in the underlying litigation without risking the possibility of inconsistent results.

Between them, the parties identified six issues that require resolution after Vice Chancellor Glasscock's opinion interpreting Article 3.7: (1) the extent of Fillip's entitlement to advancement for the Dismissed Counterclaims; (2) whether Fillip is entitled to advancement for Counts I and II of the Third Amended Counterclaims; (3) whether Fillip is entitled to advancement for certain of Centerstone's Affirmative Defenses; (4) whether Fillip is entitled to advancement relating to his efforts to enforce the alleged settlement agreement in the Georgia Action; (5) whether Fillip's advancement right is subject to a repayment obligation; and (6) the extent to which Fillip is entitled to "fees on fees" in this action. Having ...


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